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Underlying securities in international funds or investments in mother funds are made in foreign currency, which makes them vulnerable to currency risk
THERE was a time when we Indians longed for anything and everything phoren. Right from perfumes and watches all the way to televisions and cameras, we drooled at those big global brands. Then, with the unleashing of economic reforms, the Indian economy took a dramatic turn from 1991 and transformed itself beyond recognition. It then was the turn of the global brands to fall head over heels on India to grab a pie of its growing prosperity.
However, today, we are in a state of worry about the threat of withdrawal by foreign investors. Times do change and how drastically! Unfortunately, the law of gravity seems to have caught up with the Indian growth story. The last few years have turned out to be a disappointment for the country's economy with global and domestic reasons conspiring to put a spoke in the smooth running wheel of India's rapid progress.
India's growth prospects, which seemed a given at about 8 per cent to 9 per cent, even quite recently, looks troubled today.
The need to diversify beyond Indian equities: It is quite obvious that no country will continue to perform well forever. Each one is going to have its own period of glory and worry (refer to the exhibit below). You can find India frequently alternating between the best and the worst performers. In general, while emerging markets are considered high potential, it is also equally true that they are more volatile.
Many emerging markets fell more than the developed markets, the originators of the 2008 crisis.
Similarly, while the BSE Sensex handsomely outperformed both the MSCI World Index and the MSCI EM Index in the 2002-2007 period, it has been quite the other way round in the 20082013 (YTD) period.
It is in this light that we need to continually review and re-evaluate our investment beliefs and practices in a dynamic world environment. We must also appreciate the risk of betting too much money on only one story. There are so many excellent businesses globally that are making lives easier and better for people. By keeping your money only within India, you are effectively ignoring 98 per cent of the global equity market. While some countries thrive on minerals and resources, there are others who have an edge in manufacturing or services.
Benefits of global investing:
Access to global industry leaders: You can participate in the wealth creation of the best and the biggest businesses globally, many of which do not have a presence in India. The largest retailer in the world, largest social networking company, largest software business and many more of your favorites can find a place in your portfolio.
Portfolio diversification: By adding global investments that have low correlation with Indian equities, the overall risk of your portfolio is reduced.
Currency diversification:
By spreading your investment across currencies, you are minimising a very potent risk. The recent sharp depreciation of the Indian rupee is a good wake up call.
Geo-political diversification: By spreading your investment across the globe, your investment will be less impacted by the political and geo-political risks of investing.
Here's an example of how a 20 per cent exposure to international equities enhanced performance even while reducing risks. The risk/return too improves, especially in bear markets.
Global investing now made easy:
Yes, scouting the global equity markets and picking from the thousands of stocks is indeed quite a task. But with mutual funds offering access to global equities through the feeder fund route, you can effortlessly invest abroad without any additional documentation or KYC procedures. On the whole, going global with your equity investing is a prudent and necessary step.
Risk factors:
Though investing globally enables diversification and also provides better risk-adjusted returns, investments are subject to several risks: Currency risk: Underlying securities in international funds or investments in mother funds are made in foreign currency, which makes them vulnerable to currency risk. Lately, the dollar has appreciated sharply against most emerging market currencies, with the domestic rupee reaching historic lows (Rs 66.25 per USD on August 27). A fund investing in, say, the US market, would benefit as follows. If an investor invests Rs 50,000 in an international fund when the rupee conversion rate is Rs 55 per US dollar (1,000 units @ 1 unit per US dollar), and exits when the conversion rate is Rs 65per US dollar, the investor's gain on account of the conversion factor would be Rs 10,000 [1,000 units * (65-55)], assuming there are no mark-to-market gains/losses. However, on the negative side, the appreciation of the rupee can result in capital loss.
Country/ geo-political risks:
International funds will always be subject to countryspecific, economic and geo-political risks pertaining to the country / region they invest in. For example, the economic dishevel caused by a tsunami and nuclear crisis in Japan in February 2011 impacted its market severely compared to other global markets.
Tax treatment:
International funds that invest at least 65 per cent in Indian stocks and the remaining in international markets are categorised as equity funds. Shortterm capital gains for such funds are taxed at 15 per cent for these funds, while longterm capital gains are tax free. Dividend received by unit holders under these funds is exempted from tax. All other types of funds (including all fund of funds) in this category are taxed like debt funds, where long-term gains would be taxed at a flat rate of 10 per cent without indexation or 20 per cent with indexation. Short-term gains will be added to the investor's income and will be taxed as per the applicable slab rates. These funds would also attract the dividend distribution tax of 28.34 per cent. Hence, investors must understand the structure of the international fund to know the tax implications.
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Invest in Tax Saving Mutual Funds ( ELSS Mutual Funds ) to upto Rs 1 lakh and Save tax under Section 80C.
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